China steel price for 2017 will decrease, following a recent report from Moody’s; Steel companies’ earnings will likely weaken in 2017 after substantial improvement in 2016.

The decline will result primarily from a slight weakening of domestic demand amid continued excess capacity and abuild-up of steel inventory in early 2017. These factors will depress steel prices, which have reached a four-year high. Elevated raw material prices and reduced exports will also weigh on steel producers’ earnings.

China domestic steel demand will decline, main causes are:

• Property investment, the largest driver of Chinese steel demand, will likely slow this year following the government’s tightening of policy in an effort to curb property-price growth.
• Auto sales, and subsequently production, will also slow owing to a reduced tax break on small-vehicle sales. These pressures will be lessened by government-led infrastructure investment, which will remain robust.

Declining steel exports will worsen oversupply and weigh on prices:

Moody’s expects steel exports to decline by a high-single-digit percentage this year, following a 3.5% decrease in 2016. The decline will be driven by increased trade barriers outside China and a narrowing price gap between the domestic and international markets, which makes exports less attractive.

Capacity reduction will continue but encounter hurdles. The Chinese government’s target to reduce the country’s steel-production capacity by 50 million tonnes in 2017, if achieved, should temper the downward pressure on steel prices and earnings.

However, the capacity-reduction effort will face hurdles that could slow the pace of reduction, such as the steel sector’s improved profitability and the impact of the closures on the steel-producing regions’ economies and employment.

The Chinese government’s ongoing efforts to increase the efficiency and profitability of stateowned enterprises (SOEs) will encourage large steel SOEs to merge with each other and acquire smaller competitors, and lead to the closure of weaker producers. The expectation is that the SOE will improve their reported financials by renegotiating terms and conditions of their existing liabilities or carrying out debt-to-equity swaps as a part of the SOE reforms.

Stringent lending requirements will also make it difficult for struggling producers to continue operating. Consolidation will increase the large companies’ market share.

Chinese steel companies’ earnings will likely weaken in 2017 after substantial improvement in 2016

Chinese steelmakers’ earnings to be lower this year than in 2016 (see below) because steel prices will decline due to a slight weakening of domestic demand amid continued excess capacity and increased steel inventory.

Elevated raw material prices and reduced exports will also weigh on earnings. The potential for further cost reductions appears limited following substantial restructurings at many steel companies during 2014-16.

Chinese steelmakers’ earnings increased significantly in 2016 owing to a jump in steel prices resulting from a slight increase in demand and substantial cut in production capacity during the year.

Large and mid-size Chinese steel companies recorded a total RMB 30 billion of pre-tax profit in 2016 versus RMB 64.5 billion of losses in 2015, according to the China Iron & Steel Association.

Those losses resulted from a sharp decline in steel prices amid weak demand and oversupply; it will be however difficult for steel companies to sustain throughout 2017 the strong earnings they generated in 2016 and so far this year. This is because the recent increase in steel prices – prices nearly doubled during the past 14 months and reached a four-year high in early 2017 (see below) – caused steelmakers to continue producing and distributors to build up inventory (see below).

Prices will decline from this high level as demand weakens and de-stocking takes place. In addition, there is reason to believe the price increase has been driven partly by a significant amount of futures trading activity which, unlike demand, is volatile and often unsustainable.

The anticipated moderation in domestic credit supply in 2017 will potentially tame speculative steel futures trading and drive prices back to the level reflecting the actual demand and supply balance.

Elevated raw material prices will also eat into steelmakers’ earnings this year.

Prices for major raw materials used in steel production, such as iron ore and foundry coke, increased by almost 90% and 130%, respectively, from 1 March 2016 to 1 March 2017 (Exhibit 4), although the foundry coke price has fallen since December 2016.

Additionally, Chinese steel companies’ bargaining power against major overseas iron-ore suppliers is weak. The fragmented nature of China’s steel industry means no producer has meaningful bargaining power.

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